Chinese firms controlled by the central government rallied strongly in the afternoon, amid continued expectations that Beijing will step up efforts to restructure its lumbering and often inefficient state-owned enterprises.

An index tracking major Shanghai-listed firms with reform hopes rose 0.5 percent to hit its highest since early 2016. It has gained more than 12 percent so far this year.

However, investors’ appetite was curbed by geopolitical concerns following North Korea’s biggest-ever nuclear test on Sunday and reports that it is preparing more missile launches.

Pyongyang is ready to send “more gift packages” to the United States, one of its top diplomats said on Tuesday.

UBS said in its monthly Asia Pacific investment report that although “U.S.-North Korea relations have perhaps reached their tensest point in decades”, military conflict is “unlikely”.

One possible risk stemming from the crisis, according to UBS China strategist Gao Ting, is potential trade friction between Beijing and Washington triggered by differences over how to resolve the North Korean issue.

“This nuclear issue. ..could affect the Sino-American relationship, and trade is part of that bilateral relationship,” Gao said.

After a strong run-up in recent months, Gao said China’s market is starting to lose some upward momentum, having fully priced in stronger economic growth. So, investors could shift attention to structural opportunities - such as those created by state-owned enterprise (SOE) reforms, which will likely spur more mergers and acquisition.

“There will be no more upside surprises in terms of earnings,” Gao said, predicting profit growth at Chinese-listed firms may slow to 5 percent in the second half, from 18 percent during the January-June period. (Reporting by Luoyan Liu and John Ruwitch; Editing by Kim Coghill)